Sell Sakthi Sugars: Edelweiss

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Edelweiss is bearish on Sakthi Sugars and has maintained sell rating on the stock.

 

Edelweiss research report on Sakti Sugars

 

Sakthi Sugars' (STSG's) Q4FY07 and FY07 results were below our estimates. The FY07 consolidated revenues fell 6% Y-o-Y to INR 9.4 billion as the sugar segment revenues, which contributed 56% to the consolidated revenues, declined 24% Y-o-Y. Consolidated net earnings (adjusted) were down 98% Y-o-Y due to the sugar segment's poor operating performance and high financial costs. To hedge its business model from the inherent cyclicality of the sugar industry, STSG acquired 'Intermet' (a European auto-component manufacturer) in May 2007 for ~INR 5.2 billion. Benefits of this acquisition is however unlikely to flow in over the medium term. A highly levered balance sheet with non supportive cash flows and an auto components business which is yet to establish its feet leads us to downgrade our recommendation from 'REDUCE' to 'SELL' on the stock.

 

Sugar bleeds on lower sales and realisations

 

STSG's FY07 consolidated revenues were down 6% Y-o-Y to INR 9.4 billion, predominantly due to the sugar segment's poor performance. The average sugar realisations for FY07 were at INR 14,420/tonne vis-à-vis INR 17,356/tonne for FY06. As the sugar segment barely managed to break-even at the EBIT level for the full year, consolidated EBITDA declined 38% Y-o-Y to INR 1.3 billion. The company however managed to report consolidated profits of INR 254 million due to one-time forex gains of INR 306 million (USD 60 million FCCB) on an appreciating rupee, which prevented it from getting into losses.

 

Changing business mix;

 

However, benefits unlikely to accrue over medium term To build a stable business model and cushion itself against the inherent cyclicality of the sugar business, STSG acquired Intermet through its 100% subsidiary Sakthi Auto Components (SACL) for INR 5.2 billion; Intermet currently has an annual capacity of 165,000 MT engaged in manufacturing precision castings in ductile iron for the automotive industry. Additionally, STSG is ramping up its cogen capacity approx 4x, to 120 MW, to shift towards a more secular and higher margin business. Benefits of these efforts are however unlikely to flow in over the medium term. Additionally, we expect the sugar business to remain under pressure with no medium term triggers which can substantially alter current sugar economics

 

Some more pain before the gain;

 

Downgrade to 'SELL' Although STSG looks attractive at P/E of 4.7x and 3.2x its FY08E and FY09E consolidated earnings, respectively, it is expensive on EV/replacement cost of 1.3x on FY08E basis. We have valued the company's auto component business at 10x FY08E earnings. A cyclical business (Sugar) facing a downturn, a newly acquired business (Auto components) yet to find its feet and a highly leveraged balance sheet with non-supportive cash flows leads us to downgrade our recommendation from 'REDUCE' to 'SELL' on the stock.

 

Segmental results

 

Reduced sugar volumes and a approx 20% dip in sugar prices lowered the sugar segment's revenue contribution to 70% in FY07 from 78% in FY06. Sugar sales for FY07 were 319,472 tonnes visà- vis 361,214 tonnes in FY06. Average sugar realisations for FY07 were INR 14,440/tonne as against INR 17,350/tonne in FY06. The fall in sugar realisations led to the sugar segment reporting 0.2% EBIT margins in FY07 vis-à-vis 17.4% in FY06; hence, the segment could contribute only 1% to overall profitability (EBIT) mix. Contribution of STSG's co-products segments (cogen and distillery) to the EBIT however increased with their increased revenue mix and margins. With sugar prices estimated to remain soft in near term and STSG expanding its cogen capacities, the net integration benefit is expected to increase further with higher revenue and profit contribution coming from the company's co-products segment.

 

Investment Theme

 

STSG has taken steps to create a more stable business model through its auto-component acquisition in Europe and cogen capacity expansion. We however expect benefits of these efforts to accrue only after the medium term; until then, the company's sugar business is likely to continue to remain under pressure. Further, Intermet will take at-least 3 years to get streamlined. Moreover, given the saturated nature of auto components market in Europe, we do not expect significant revenue growth from the geography. In the absence of supportive cash flows, a highly leveraged balance sheet causes huge concern over the medium term. We maintain our negative stance on the story over the medium term.

 

Key Risks 

 

Given that the overall profitability has a strong correlation with the sugar price movements, any dramatic improvement in domestic sugar prices in the near term could enhance operating cash flows. STSG's business model is complemented by locational advantage (proximity to ports); hence, an improvement in global sugar prices by approx 15% plus would be a positive for STSG and thereby improve profitability. Higher than expected revenue growth from the company's auto components business could surprise us on the positive side.